Backdated options: The next great scandal

From MSN Money, 5/29/06

A growing number of companies are being investigated over the practice of backdating options so corporate insiders can reap millions essentially risk-free.

By Bill Fleckenstein

"Make money risk-free!" That's usually a costly come-on, as ordinary folks know. But corporate chieftains who sit on their stash of stock options have found a way to turn this unattainable fantasy into reality.

To begin this week's portrait of greed outdone by temerity, I'd like to reprise the following from my April 4, 2005, Contrarian, "Dear CEOs: Stop fudging your numbers:"

"It used to be that highly respected corporate chieftains were focused on building their businesses with an eye toward the future, and weren't overly concerned with the next 90 days' results. However, since the stock-options era of the mid-1990s, what has often appeared to matter most to those in charge is the business of managing their companies' stock price."

Execs proactive ... in matters retroactive

As if that loss of focus weren't enough, we can now add a new one. To wit, regulators are investigating at least 22 companies regarding whether they may have improperly backdated stock-options grants. It's a subject that was presented clearly last Monday in a Wall Street Journal story headlined "Five More Companies Show Questionable Options Patterns." (Registration may be required.)

As the story correctly noted, if you backdate an option, you take the risk of the option out of the equation (and you get to make a whole lot more money). Therefore, you are not aligning the shareholders' and the executives' interest -- that alignment of interest being the supposed raison d'être for utilizing options.

In any case, I've been told by folks closer to Silicon Valley than I am that this sort of activity was rampant, though I myself do not have any firsthand knowledge of its occurrence. You can be sure that if options-backdating was widespread, it's all going to come out.

The 'impeccable' timing of inflation

Meanwhile, in perfectly perverse fashion, it's beginning to come out at a time when the public is already peeved about the absurd amounts of money that so many corporate chieftains make. Now, the public is liable to find out that in addition to essentially cooking the books to win at beat-the-number, these chieftains may have rewarded themselves with options that basically were risk-less.

All this is happening at a time when the public is starting to realize it's being squeezed on the inflation front, as price increases and fuel-cost surcharges permeate the landscape. As I said last week, inflation is an idea whose time appears to have come. That the public is starting to feel poorer will only increase the outrage at shenanigans in the executive suites.

That outrage will only intensify when folks who've speculated in the housing market start to feel the real pain -- which will bring about the next big scandal: fraudulent appraisals and bogus financing schemes.

Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily "Market Rap" column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money. At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column.

(Thanks to John Bos for submitting this article.)